Holland Mountain’s Kimberly Ellis reflects on the increasing importance of ESG for investors following the recent conference hosted by Real Deals & the Drawdown.

Attending an in-person conference in Jan 2022 feels like a huge step forward and bringing together 25+ influential industry leading experts for ‘ESG, Explore, Strategise and Grow’ was the ideal platform to discuss the importance of ESG for investors with thought leaders from across the Private Capital community. We heard about the next ‘wave of thought’ in ESG investing which is ‘Just transition’, a new policy to break the mainstream pattern of behaviour.  It’s clear that our industry is embracing the new SFDR regulations, but not without a lot of readjustment, and investment in personnel and technical resources.

Reflections on keynote address by Peter Dunbar, Private Equity Senior Specialist at PRI

Investing in a sustainable way has become a hot topic, with an urgency for the Private Capital industry to incorporate ESG issues into their investment strategies. Notably, in the last year alone there has been a huge interest in ESG take-up with over 1000 sign-ups to UNPRI, the world’s most recognised list of ESG principles. This takes the total number of signatories to 5000, mainly in Europe and the US.

PRI has directed focus recently to venture capital, launching VC collaboration to strengthen ESG take-up. It’s widely recognised that VC deals can be hugely influential to how we live in future but VC in tech can carry both positive and negative effects that need to be assessed by investors. A survey has shown that the VC industry focuses on the ‘S’ and ‘G’ issues, however more collaboration is showing traction in ‘E’ issues e.g., energy consumption of cryptocurrencies. ICI, the Initiative Climat International, which is a PRI Collaboration Platform, supports Private Equity’s action on climate change, with a collective commitment to understand and reduce carbon emissions using science-based targets. PRI has a number of publications on VC case studies, biodiversity, human rights, PE and a PE credit pre-investment ESG data sharing template which pull together competing frameworks, for further reading.

Will new ESG regulations work or will they result in even more box ticking?

During the debate on new ESG regulations, we heard from Ravi Bhatt, Vice President for Responsible Investment at Apis Partners, Jan Gruter, Partner, Investment Management Team at Addleshaw Goddard, Amandeep Singh Johal, Legal Counsel Portfolio Governance at Triton. Talya Misiri, Editor at Real Deals was moderating.

Whilst SFDR is helping to gain data convergence with its framework, delays in its release have been challenging for GP’s and LP’s. Reporting under SFDR will create transparency and consistency but it has to be meaningful to investment committees, investors and the public. It will take the Private Capital industry time and resources, shifting the focus on building a strategy with ESG factors at its core, to make real progress. Box ticking is perhaps inevitable due to a rigid structure and a compliance burden that has no choice but to be accepted. Regulation will help investors achieve a level of transparency but LP’s foresee challenges, seeing SFDR as more work. For newer LP’s the SFDR is useful, however for other LP’s, DFI’s or impact investors, getting to a place of standardisation is a ‘dream’ but not a reality at this point as a harmonised set of indicators do not exist. As a minimum, the role of the SFDR will be to set standards or benchmarks to allow for comparisons. The first set of requirements went live last year but there was no standardisation of technical standards. A final draft is coming but in the meantime, firms are fighting to stay in line. The good news is that sustainable investment is here to stay. Whatever issues there are, SFDR regulation has begun and the hope is that it doesn’t impact too much on entrepreneurial GP’s.

Later in the day, Matthieu Ducharme, managing director at Northleaf Capital Partners talked about what’s next on the ESG agenda for LPs. He highlighted how resource intensive, and expensive it has become to meet the pressures put on the complex ESG regulation, however he did note that there is now a landscape of service providers and tools GPs can outsource to in order to assist with ESG processes. Holland Mountain can provide insight into these options, so please do get in touch if you would like to discuss.

ESG in the due diligence process

The ESG section of ILPA’s new DDQ, version 2.0, is based on the PRI’s LP private equity responsible investment due diligence questionnaire. Following feedback from market participants, the new DDQ template includes sections on succession planning, co-investments, GP-led secondaries, cybersecurity, recruitment, culture, HR etc.. There are some great examples such as Blue Horizon, an impact investor, which has built their own impact framework, making a huge difference to the way they view investments, screen deals and ensure the deal process timelines aligns with the DD process. Triton applies an ESG lens to all investments and Zealand Capital have added ESG to its board agenda, making it a key priority across their investment process.

Investing in ‘Just Transition’

Just Transition’ is a “vision-led, unifying and place-based set of principles, processes, and practices that build economic and political power to shift from an extractive economy to a regenerative economy”. It offers the opportunity to solve three key challenges at once: Climate change, growing inequality and social inclusion with a moral obligation to think about and achieve a more sustainable economy.

So, what can GP’s do to support ‘Just Transition’? At this year’s G7 there was an impact investment taskforce focusing on the analysis of ‘Just Transition’ and they mapped out a blueprint for investors, whilst at the COP26 climate summit, ‘Just Transition’ advanced as a critical factor for enabling a successful shift to a net-zero and resilient economy, almost six years after it was included as a single line within the Paris Agreement. At least 10 new ‘Just Transition’ initiatives were launched at COP26 with a direct or indirect focus on making the ‘Just Transition’ a reality. These decisions will have serious implications for future efforts across the financial system.

Key priorities on the ‘Just Transition’ radar for the financial system in the lead-up to COP27 are as follows.

  • Make the ‘Just Transition’ integral to net-zero plans
  • Focus on emerging and developing economies
  • Deploy tailored financial instruments and mechanisms
  • Support ‘Just Transition’ policy and regulation
  • Recognise the crucial role of dialogue and participation.

ESG reporting – how can technology help?

For many asset managers, the main challenge of SFDR will be reporting detailed product-level ESG characteristics, starting in 2022. New technology solutions enable fund managers to measure and report on ESG matters in all kinds of formats. And, with new EU rules coming into play, in order to comply, GPs must ensure they have the right systems in place to handle the entirely new set of ESG disclosure demands. For example, Stanley Capital has a standardised scorecard and ESG metrics integrated into their value creation plan to meet regulatory obligations. It’s true that ESG is very qualitative making it more difficult to collect the right type of data so the bigger the firm, the more complex and larger volume of data there is. It’s also important to avoid this being seen as a back office matter, so ESG considerations should be closely linked to compensation and incentivisation. The culture shift we expect to see is from profit-driven to purpose-driven. Ultimately, success will rely on ESG technology being deployed across the company, with ESG principles embedded within the values of the firm, informing all future decision-making.

Kimberly Ellis

Managing Consultant

Kim leads Holland Mountain’s middle office practice, focusing on portfolio monitoring, valuations and ESG. Kim works closely with Private Capital firms to provide strategic advice on operating models and offering best practice recommendations for the successful delivery of operational improvement projects. As a Private Capital expert, Kim has extensive experience in Private Capital operations and systems, having managed system selection, implementation, remediation and continuous improvement projects.